Perturbed Copula: Introducing the skew effect in the co-dependence

Alberto Elices and Jean-Pierre Fouque

Papers from arXiv.org

Abstract: Gaussian copulas are widely used in the industry to correlate two random variables when there is no prior knowledge about the co-dependence between them. The perturbed Gaussian copula approach allows introducing the skew information of both random variables into the co-dependence structure. The analytical expression of this copula is derived through an asymptotic expansion under the assumption of a common fast mean reverting stochastic volatility factor. This paper applies this new perturbed copula to the valuation of derivative products; in particular FX quanto options to a third currency. A calibration procedure to fit the skew of both underlying securities is presented. The action of the perturbed copula is interpreted compared to the Gaussian copula. A real worked example is carried out comparing both copulas and a local volatility model with constant correlation for varying maturities, correlations and skew configurations.

Date: 2010-02, Revised 2012-02
New Economics Papers: this item is included in nep-ecm
References: View complete reference list from CitEc
Citations:

Published in Reduced version published in Risk Magazine, Vol. 25, No. 1, pp. 98-103, January 2012

Downloads: (external link)
http://arxiv.org/pdf/1003.0041 Latest version (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:1003.0041

Access Statistics for this paper

More papers in Papers from arXiv.org
Bibliographic data for series maintained by arXiv administrators ().